With consensus divided, Deere caught in analysts’ headlights

By Nicholas Heinzmann

Deere & Co. shares have slumped this year following a collapse in grain prices, and Wall Street is sharply divided on whether the stock can turn around. 

Shares of the Moline, Illinois-based equipment company have tumbled 15.2 percent in the past two quarters, to a low of $80.01 in October from its year high of $94.38 in May. Plummeting corn prices caused Deere to lower its revenue estimates for the year: Worldwide sales of agriculture and turf equipment are expected to fall 10 percent compared with 7 percent in a previous outlook.

In response to weak farm machinery sales in North America and Europe, the world’s largest maker of agricultural equipment is looking toward other segments of its business to right itself. It has invested heavily in emerging markets such as India and Brazil; shifted its focus toward machinery for livestock production, for which demand is growing; and positioned itself to gain market share from competitors AGCO Corp., based in Georgia, and CNH Industrial, based in the United Kingdom.

But there is little consensus on whether these strategies will work. A slim majority of 10 analysts advised holding shares while seven suggested buying and nine saw them as overvalued, according to a Bloomberg survey. This lack of common consensus is unusual, particularly for a well-established company such as Deere.

Morningstar Inc. analyst Kwame Webb, who suggests holding the stock, lowered his estimate for Deere to $90 from $95 per share in September. “We expect sales to decline in 2014 and 2015 for farm equipment,” Webb said in a research note, citing lower crop prices and reduced corn acreage as factors weighing on the outlook.

From 2009 to 2013, Deere reaped the benefits of high grain prices and record farm incomes. Net earnings grew a staggering $2.7 billion, quadrupling to $3.6 billion from $873.5 million. Revenue soared 63.5 percent, rising to $37.8 billion from $23.1 billion.

Now a reversal of fortunes in the farm economy has put a wrench in Deere’s growth. Record yields plunged corn futures at the Chicago Board of Trade to a low of $3.18 per bushel on Oct. 1, down 48.3 percent from $6.15 per bushel in 2011. Soybean futures have also suffered, hitting a $9.12 per bushel low on Oct. 1, down 30.6 percent from $13.16 per bushel high in 2013.

DE-sales-revisedDespite this blow to Deere’s major profit center, Webb said the company’s strong fundamentals should protect it from the weak farming outlook.

“We think Deere is best positioned to capitalize on a soft environment,” Webb said in a separate statement. “It’s higher profitability relative to peers and low industrial debt levels give it the most opportunity to pursue value-accretive acquisitions or opportunistically invest to gain market share.”

To be sure, challenging its competitors in Brazil has been a major focus for Deere as of late. The company invested $180 million along with Hitachi Construction Machinery to build two factories in Brazil that were completed in February.

“As one of the fastest growing construction equipment markets in the world, Brazil offers a great opportunity for John Deere Construction equipment,” said Michael Mack, president of John Deere Construction & Forestry, in a press release at the time. “The investment potential on infrastructure is very high in Brazil, which makes us confident in the success of this enterprise.”

That risk may be paying off. While agriculture machinery revenues declined 11 percent in the third quarter, construction and forestry revenues rose 19 percent. Analysts such as Matt Arnold, of Edward Jones, see this growth beyond farm machinery as a way to offset lower demand for tractors and combines.

“Deere continues to execute effectively amid a downturn in the agriculture markets,” Arnold wrote in a report. He said future construction sales “are likely to follow GDP growth of 2 percent to 4 percent in developed regions such as North America and 5 percent to 8 percent in emerging markets.”

But that outlook is flawed in the minds of analysts who see Deere’s stock as overvalued. They see the company’s long-term ambitions as wishful thinking.

“Overall, management appears a bit optimistic about the outlook,” said J.P. Morgan analyst Ann Duignan in September after touring Deere’s manufacturing facilities in Brazil. Deere’s target to be the third-largest supplier of construction and forestry equipment in Brazil by 2018 “seems like a stretch,” Duignan said, noting that stealing market share from competitor Caterpillar Inc. would be no easy task.

Furthermore, Brazil’s agriculture economy in 2015 may be subject to some of the same forces affecting U.S. farmers now.

“The fundamentals in Brazil continue to deteriorate with farmers expected to generate losses on most major crops,” Duignan said in a note Oct. 15. The end of a Brazilian government program in November that subsidizes farm equipment purchases could add to uncertainty, Duignan said, and while Deere could post a strong finish in 2014, that “is likely to lead to greater disappointments” in 2015.

While Deere’s stock outlook remains disputed, the company’s performance reflects target price consensus. Deere’s closing price Thursday was $85.23, only slightly above a median target price of $84.37 in a Bloomberg survey.